NCUA Reminds Credit Unions to Exercise Great Care with Member Business Loans to Self-Employed Borrowers

ALEXANDRIA, Va. – Lending to self-employed borrowers typically carries much more risks, but tax safeguards are in place to protect credit unions from mitigating circumstances down the road, NCUA recently advised. NCUA Chairman JoAnn Johnson said as member business lending continues to grow, credit unions need to remember the unique risks associated with underwriting loans to self-employed borrowers. A self-employed borrower is an individual who has a 25% or greater ownership interest in a business, Johnson said. The business may be a sole proprietorship, partnership, or corporation. “Self-employed borrowers present a unique underwriting risk because, in general, new small businesses have a high failure rate, the borrower’s income typically fluctuates from year to year, and the borrower may be personally liable for the debts of his business,” Johnson said. As a safeguard, Internal Revenue Service Form 4506-T allows credit unions to request transcripts for the following tax returns: Form 1040 series, Form 1065, Form 1120, Form 1120A, Form 1120H, Form 1120L, and Form 1120S. The type of return varies by the business structure-sole proprietorship, partnership, or corporation. Credit unions can ask the borrower to sign an IRS Form 4506-T and enter the credit union’s name, address, and telephone number on line 5. Transcripts of the borrower’s tax returns are typically received within 10 business days of sending the completed Form 4506-T to the IRS. The IRS offers this service free of charge. Johnson said one typical underwriting procedure associated with self-employed borrowers is to obtain copies of the borrower’s individual and business tax returns for the past two years. “Consider comparing the IRS tax return transcripts to the tax returns submitted by the borrower either as a quality control check after loan closing or as part of the underwriting process,” she said. To mitigate any further risks associated with granting a business loan to a self-employed borrower, loan underwriters need to consider both the individual borrower and the borrower’s business by reviewing existing borrowing relationships with the applicant; size and type of business; demand for the business’s service or product: borrower’s level of experience in the business; borrower’s cash flow available to service the debt, and overall financial strength of the business. Johnson said underwriters should also analyze the self-employed borrower’s business plan to assess the company’s strategic plans over the life of the loan. “As you strive to meet the small business loan needs of your members, we encourage you to evaluate your related policies and procedures to ensure you have established controls to mitigate the increased risk,” Johnson said. At the end of 2003, outstanding member business loans at federally insured credit unions doubled to more than $8.8 million, or 2.4% of total loans. [email protected]